It’s war. At least in Donald Trump’s world, describing himself as a “wartime president” in the fight against the coronavirus pandemic. True, public spending is set to reach levels last seen after World War II. However until the Forties, wars were paid in gold because bankers did not want to take the currency of the loser. In fact, the gold standard worked well for centuries. However at the end of World War I, Germany had to pay their reparations with gold, but the financing strain was so huge that they suspended the gold standard and instead financed their obligations with borrowings, thus paving the way for the Weimar Republic hyperinflation.

On and Off the Gold Standard

Ironically, back then, Britain’s pound was the world’s reserve currency, but they too had very heavy war bills to pay and were also forced off the gold standard in 1919 because of a run on the pound. The slump of the Thirties followed. And, after the second war in 1944, the victorious allies came up with a system, which replaced the pound with the US dollar under the Bretton Woods Agreement, making the dollar, the world’s reserve currency.

In early 1933, the US government also devalued, abandoning the gold standard and confiscated everyone’s gold at $20.67 per ounce. The government then devalued the dollar, pegging the dollar at $35 per ounce, resulting in a competitive “beggar thy neighbour” policy with its trading partners, which paved the way for Hoover’s Smoot Hawley Tariffs. The devaluation caused money supply to explode allowing Franklin D. Roosevelt to pay for his New Deal, which kickstarted the economy. In fact, the gold held in Fort Knox today is from the gold seized by the American government.

Under the 1944 Bretton Woods Agreement, the world was under a dollar/gold standard and the United States held roughly 60 percent of the world’s gold supply. But soon there was more dollars than gold so in 1971, President Nixon severed the gold link which turned money into paper. The financial strain of the Vietnam War and the cost of Lyndon Johnson’s “Great Society” caused a run on the dollar. Nixon closed the gold window breaking up the Bretton Woods Agreement, making the dollar the world’s dominant fiat inconvertible currency. Other countries followed and fixed their currencies against the mighty dollar, not gold. After 1971, the US economy fell out of bed and gold went from $35 an ounce to over $350 an ounce.

Of course, over the subsequent decades, the US enjoyed a virtually unlimited line of credit in its own currency. Without the discipline of gold, the United States racked up horrific amounts of debt to finance its large and growing deficits, consumption and wars. And while the markets have stumbled from crisis to crisis as the Fed monetized ever greater quantities of government liabilities, the United States’ financial hegemony has allowed it to impose sanctions, as such that foreigners have resented this abuse of the dollar’s power. Today the world’s faith in the dollar is being tested. History showed that in Germany, Britain and now in the United States that at some point, a day of reckoning occurs. With the United States, becoming the largest debtor in history and conducting a full-scale bailout of everything, that day is soon.

The Golden Constant

Today, the world financial system is awash with dollars and yet another wave of dollars is being produced which will no doubt cushion the global economy, but at a huge cost of a more indebted financial system.

Economic history tells us that when central banks print a lot of money, inflation rises. It is a monetary phenomenon. We consequently believe that hyperinflation is a greater risk today than the 1930’s style of depression.

We believe that entering the “never normal”, the dollar’s days are numbered due to this massive creation of dollars from the bailouts and America’s earlier fiscal profligacy. The world is drowning in an avalanche of cheap dollars as America must pay for its debts and deficits. And that is the problem. Policymakers, oblivious to the past are acting to cushion their economies to avoid a deflationary depression but America’s position is weaker than investors think. Unlike collateralized debt obligations, Boeing shares or Central Park condos that have lost value recently, gold has never been completely worthless. It was FANG stocks last year, this year the “never normal” will be gold, a trusted store of value for centuries.

So the rise in gold is not a surprise. Gold is a currency and if investors believe that currencies are failing, gold is an effective hedge and store of value. In fact gold has posted record highs in euros and yen, trading at an eight year high in dollars, increasing by a third in the past two years. Gold is the canary in the coal mine. In this century we have seen a series of upheavals and at long last because of America’s profligacy, Covid-19 and rising debt load, the dollar’s dominance is being questioned. Without confidence in the dollar, the world has no valid reserve currency. Gold is an alternative to the dollar. As for the pandemic, gold is a perfect hedge. It is risky either way. If the virus persists or the inevitable “deadly second wave” occurs, gold will rise on the effects. If a vaccine is found, gold will rise on the hangover of the cure.

Skeptics believe gold’s performance is a “flash in the pan”. They are wrong. Gold’s rise shows that investors are nervous. While gold is a barometer of investor anxiety, over the longer term, gold is a hedge in both deflationary and inflationary times. While inflation was mostly absent for much of the decade (except for real estate, bonds, classic cars and the stock market), we think that after the deflationary Covid-19 forces abate, the consequences of the largest fiscal stimulus in history will prove to be inflationary, maybe even hyperinflationary. In November, the Americans will elect another inflationary president. Gold will be a good thing to have in this “never normal “climate. We continue to call for a near term target of $2,200 an ounce but expect higher prices before the end of this cycle.

Recommendations

Much is made of the almost decade-long period when gold miners lagged bullion. The main reason is that until the last couple quarters, the miners were not generating free cash flow due to higher costs, stretched balance sheets and falling mine grades. For a time they were poor investments. Except for declining grades, the other factors no longer weigh on the group and to no surprise, gold shares have outperformed the markets. Recent first quarter results show most with free cash flow and widening margins. As investors rediscover their appetite for gold, we believe gold stocks’ bull run has only begun.

Still the industry faces a dilemma of declining reserves. Few replaced reserves last year forcing some to buy ounces on Bay Street through M&A activity because those ounces remain cheap. Newmont’s acquisition of Goldcorp and Kirkland Lake’s takeover of Detour are examples of the ongoing consolidation of the industry and the quest for reserves. Competition too will come from the big state- owned Chinese producers, who faced with declining reserves will gobble up the weaker producers as Shandong bought out TMAC. With fewer gold companies, we believe the Street is ready to back a new crop of players so we expect a spate of “bulking up” acquisitions by the mid-tiers who will feast on the “non-core” assets of the seniors. Teranga’s acquisition of the Massawa Gold project from Barrick is a good example. The developers, like McEwen Mining and Osisko are the next sweet spot. Finally we believe that the cash rich producers will finally boost exploration, a core function but there will be much more interest in “brownfield” projects that have been neglected and starved for cash.

We continue to like the majors like Barrick Gold, Agnico-Eagle and mid-tier players B2Gold and Lundin Gold (LUG) for high grade Fruta del Norte in Ecuador and a takeout by Newcrest.

• Barrick Gold Corp. (ABX) – Barrick had a strong quarter earning US$400 million allowing the miner to further improve its balance sheet. Barrick generated $438 million of free cash flow on 1.25 million ounces of production from its high quality mines. After creating the Nevada merger with Newmont, Barrick has six Tier I mines but is stymied by the lack of other Tier I assets. As such they are still eyeing copper assets to boost Lumwana’s contribution. After settling with the Tanzanian government last year, Barrick is teeing off with the Papua New Guinea government who in a shakedown, said they would not renew Barrick and China’s Zijin joint venture license. The Porgera mine was put on “care and maintenance”. Like Tanzania, we expect this to be resolved because no government wishes to kill the golden goose. Barrick has about 71 million ounces of reserves and an excellent pipeline of projects with expansions at Cortez and Veladero. Buy.

• B2Gold Corp (BTO) – B2Gold had a strong quarter generating $70 million of free cash flow. B2Gold doubled their dividend and with cash of $208 million against debt of $220 million, the mine is virtually debt free. B2Gold is expanding flagship Fekola and the expansion will be completed in the third quarter for a nine year life averaging 500,000 ounces a year. We like B2Gold for the rising production profile, management expertise and reserves of almost 7 million ounces. B2Gold is a low cost producer after selling higher cost Limon and Libertad in Nicaragua last year. Buy.

• Centerra Gold Inc. (CG) – Centerra has three operating mines in Mount Milligan, Kumtor and now Öksüt in Turkey. Centerra generated free cash flow but production was lower than projected due to Mount Milligan’s copper/gold operation in British Columbia, which halved reserves by 49 percent last year. Soon to be commissioned Öksüt in Turkey contributed in the quarter. Centerra will release a new life of mine plan for Kumtor in Kyrgyzstan this year after a 43-101, which should boost reserves and mine life. We prefer B2Gold here.

• Eldorado Gold Corp. (ELD) – Mid-tier Eldorado produced about 116,000 ounces and generated $23 million of free cash flow. Eldorado’s Lamaque mine in Quebec was shut down due to Covid-19 but operations were restarted mid- April. Eldorado drew down $150 million on a revolver and tapped their $125 million ATM giving them some balance sheet flexibility. Eldorado has key operations in Turkey with Kisladag and Efemcukuru and Greece, but the Greek government permit stalemate has kept Eldorado in the doghouse. We prefer B2Gold here.

• IAMGOLD Corp. (IMG) – It is tough to lose money in the gold mining business today but IAMGOLD managed that feat due to higher costs and lower production. Essakane in West Africa was a disappointment due to lower grades. Rosebel in Suriname had a better quarter. IAMGOLD does have a strong balance sheet with liquidity of almost $800 million against debt of $419 million together with an ill-advised forward gold sale of $170 million for stillborn Côté Lake. IAMGOLD has too many high cost assets and operating execution has been disappointing.

• Kirkland Lake Gold Ltd. (KL) – Kirkland posted a strong quarter with the help of newly acquired Detour Gold in Ontario. Total revenues jumped 80 percent on 330,000 ounces produced in the quarter. Kirkland’s all-in sustaining cost was higher at $776 because of Detour’s lower grade output. Kirkland generated almost $145 million in free cash flow and has about half a billion in cash. High grade Fosterville in Australia had a good quarter while Detour generated positive cash flow. Detour was bought to add to Kirkland’s short reserve life and the acquisition for shares significantly extends Kirkland’s life.

• Kinross Gold Corporation (K) – Kinross doubled earnings producing 560,000 gold equivalent ounces. The drop in output was due to Russian Kupol and flagship Paracatu in Brazil. Tasiast in Mauritania had a good quarter but the union walked off the job and the miner is still negotiating with the Mauritian government. While Kinross has a strong balance sheet with $1.1 billion of liquidity, its maturing assets and, notwithstanding decades long operations, the miner still has an unhealthy geographic exposure to Russia and Mauritania. La Coipa was approved but the capex is too high. We prefer B2Gold here.

• Newmont Mines Ltd. (NGT) – Newmont had a strong quarter with production of 1.5 million ounces, up 20 percent. Reserves stand at 100 million ounces. While free cash flow was $600 million, all-in-costs (AIC) increased to $1,000 due to the higher cost of Goldcorp’s mines. Yanacocha had a strong quarter but it appears that Eleonore, Musselwhite and Cerro Negro are works in progress. The company is still restructuring its portfolio of 12 miners and has high hopes of turning around Penasquito’s polymetallic mine in Mexico, which management believes is a Boddington look-alike. Newmont has a strong balance sheet with net cash of $3.7 billion and long term debt at $6 billion. During the quarter, Newmont bought back $300 million of share repurchases as part of a $1 billon buyback to offset the Goldcorp purchase. We prefer Barrick here.

Editor’s Note: John Ing is the President and CEO of Maison Placements Canada, an independent, Toronto-based investment dealer providing a comprehensive array of financial services to institutional investors and small to midsize corporate clients. Throughout his career of 50 years, Mr. Ing has been an advocate of gold investment and authored numerous articles, appearing regularly in the media together with speeches around the world in support of his golden views. For more information on Maison Placements Canada, visit www.maisonplacements.com.

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